1. Prove the following theorem: "The present value of forecasted economic profit, when discounted at the weighted average cost of capital, plus the book value of assets, equals the DCF value of the firm."
2. Suppose that a firm has project that was started last year, and it is expected to earn less than its cost of capital if left unchanged. Management comes up with these suggestions.
a. Invest in a debottlenecking project that will raise economic profit, but not up to the cost of capital.
b. Cut operating costs but not enough to earn the cost of capital.
c. Sell the unprofitable business unit for a premium over its book value.
Some numbers are given in Table Q13.2. Value each alternative and compare them in terms of value creation.
3. Some companies measure performance by requiring both "top line" growth and "bottom line" growth (i.e., growth in revenues and growth in net income). Is this performance measure consistent with shareholder value creation? Why or why not?
4. Jensen criticizes "kinked" relationships between pay and performance. How well do the following compensation schemes fit a linear relationship?
a. Stock option growth
b. Stock growth
c. Fixed salary plus variable bonus based on exceeding expectations.